When Is Money Legal Tender?

Each country determines what is legal tender within its own borders. Each government can determine what is legal tender within its borders, but contrary to popular opinion, legal tender and money are not necessarily synonymous. Legal tender is not a means of payment that must be accepted by the parties to a transaction, but it is a legally defined means of payment that cannot be refused by a creditor in satisfaction of a debt. Legal tender status only refers to the settlement of debts. Commercial transactions in which one person buys a good or service from another can be carried out with currency, checks or credit cards. Since it is a private transaction, neither side is legally obligated to accept a particular form of payment. You can divide currencies into four categories:

Legal tender currency (notes and coins) that are still in use.

Legal tender currency that is outmoded. These are coins or notes that still have legal tender status, but have dropped out of circulation. For example, Silver Certificates are still legal tender in the United States (as are all banknotes issued since the Civil War), and though they could be used to pay a debt, you are unlikely to get one in circulation. In most cases, the currency has a greater numismatic value than legal value.

Demonetized but redeemable currency no longer has legal tender status, but the issuer, usually the central bank, will exchange the notes and coins for the current legal tender. For example, German Marks ceased to be legal tender on January 1, 2002, but the Bundesbank has placed no time limit on converting Marks into Euros.

Demonetized and irredeemable currency is legally worthless. Generally, their only value is to collectors.

Irregardless of legal tender status, money refers to whatever is commonly accepted as a medium of exchange. In this sense, the US Dollar exists as money in most countries of the world, even though it is legal tender within a limited number of countries.

In 1800 coins were the principle medium of exchange in most countries. By 1900, bank accounts and banknotes had largely replaced coins for all but the smallest transactions. For example, in Germany in 1835, 76.9% of the money supply was in the form of coins, 7.4% in banknotes and 15.7% in deposits. By 1884, the percentages were 12.7% in coins, 13.7% in banknotes and 73.6% in deposits. (Heinz Fengler, Geschichte der Deutschen Notenbanken vor Einfuehrung der Mark-Waehrung, Regenstauf: Heinrich Gietl Verlag, 1993, p. 123) Similar figures could be provided for other countries.

As the economy and market expanded during the Nineteenth and Twentieth Centuries, banks began to play an increasingly important role in the economy. As banks began printing banknotes as a substitute for money in the nineteenth century, there could be thousands of banks printing their own banknotes, each of which had to be evaluated separately. The banknotes were cashed at different discounts to their face value, depending upon the probability of receiving payment and the cost of sending the banknotes to the issuing bank that would redeem them.

It should be remembered that paper money was subsidiary to commodity money in the Nineteenth Century and not vice versa. In most countries, private banks were the primary issuers of paper money, which had to be backed by gold, silver or government bonds. Centralized France was one of the few countries that did not allow private banks to issue their own banknotes.

During the Nineteenth Century, the "money question" was over whether to use gold or silver to back each country's currency. England chose gold while France chose silver and the United States chose bimetallism, relying on both gold and silver. Many Latin American and Asian countries chose silver as the basis for their financial system and linked their currency to either the French Franc or Mexican Silver Dollar, while most European countries eventually went on the Gold Standard.

This monetary regime contributed to the stability of the monetary system. Governments provided commodity money whose value was determined by the weight of the gold or silver in each coin. Banks could issue their own currency, but only if it were backed by gold, silver or government bonds. This limited increases in the money supply and preventing the debasement of the currency.

Many people were suspicious of government-issued banknotes because countries that did issue paper money in the Nineteenth Century, such as Austria and Russia suffered inflation. Consequently, when governments did issue their own currency, they made them convertible into gold or silver. The United States, for example, issued both Gold Certificates and Silver Certificates during the Nineteenth and Twentieth Centuries.

During the Nineteenth Century, most governments revoked the right of private banks to issue banknotes and became the monopoly issuers of currency within each country. Today, only Hong Kong, Macau and the United Kingdom (Scotland and Northern Ireland) allow private banks to issue banknotes.

Business began to rely more and more on checks and other institutional means of making payments, reducing the importance of coins and paper money in the economy. These changes made it easier for the government to control and unify the monetary system and to create the exchange regimes that dominate the world's monetary system today.

An important turning point was World War I. The war forced countries off of the gold standard and onto a Fiat Money standard in which the government controlled the currency, for better or usually for worse. During the interwar period, countries tried to return to the Gold Standard of the 1800s, but these attempts were a failure. The pre-war monetary stability never returned. With the government controlling the money supply, countries suffered inflation or deflation, but rarely price stability.

From 1949 until 1973, a Dollar Standard dominated the world's currencies, and all currencies were registered with the IMF in terms of their value relative to the United States Dollar, not to gold. New currencies were introduced whenever nations gained their independence. Most countries outside of Eastern Europe and South America were able to maintain stable currencies until the 1970s, but after that many currencies began to fall apart.

Since 1973, countries have had to choose between allowing markets to set the value of their currency, fixing the value of their currency against another currency, or some combination in between. This freedom has come at a price. Many countries inflated their currency leading to the death of many of them. The worst example is Yugoslavia, which went thorugh four currencies in almost as many months in 1993 and 1994.

Given all of these facts, you can see why determining when a currency is a currency is not always easy. Nevertheless, whether you are looking at the Twentieth Century or the Nineteenth Century, governments define currencies. Our goal is to determine when there were significant enough changes in the definition of a nation's currency to differentiate between a new currency and an old currency. In every case, the government must have, in some way, redefined their currency relative to what existed in the past to justify the introduction of a "new" currency.

Exchange rates tell individuals how much of one currency they can receive for another. Until World War I, most international transactions were in bills of exchange. Someone in London who wanted to import good from New York could arrange through their bank to provide payment in US Dollars in New York. Because of delays in communications, most transactions were "futures" contracts that had to allow for the delay in getting the demand for foreign exchange to the other port. Rates were usually calculated for 90 days.

With the introduction of transoceanic telegraphic communications, international monetary transactions could be carried out instantly, a significant advance when it occurred. Exchange rates were quoted for bills due when presented "at sight", bills with a short usance of up to 3 months, and bills of a long usance of 4 or 6 months. Rates for these bills differed because the 90 days that separated the different bills meant a loss of interest, and this loss of interest had to be built into the exchange rate. Governments also imposed a stamp duty on bills of exchange, and this affected the exchange rate as well. If you knew the interest rate and stamp duty, you could easily calculate the rate of exchange for any maturity bill, even though it wasn't quoted.

In addition to providing payment through bills of exchange, and later telegraphic transfers, payments could be made by shipping gold, though this carried high transportation costs and risks, but could occur if the par values of gold coins differed significantly from the exchange rates due to swings in supply and demand. The cost of shipping gold from one country to another limited the swings in the value of the currency away from par. The point at which it was cheaper to ship gold rather than telegraph money was known as the "gold point".

For example, in January 1915 it cost about $0.024 to ship gold from New York to London and about $0.039 to ship gold from London to New York. With the par value set at $4.866, this meant that the US Dollar-British Pound gold points were at $4.827 and $4.89. Similar gold points were 25.325 and 25.125 for the French Franc against the British Pound and 20.52 and 20.33 for the German Mark against the British pound. Gold points could vary as transportation costs and risk changed over time.

Payments could also be made by sending government bond coupons from one country to another once the international bond market developed toward the end of the 19th Century.

As most major economies switched to a gold standard toward the end of the 1800s, exchange rates between the major economies became fixed, and remained that way until these countries went of the Gold Standard at the beginning of World War I. There was even a push to provide a single gold coin standard for Europe and America in the 1870s, but these efforts failed.

Under the Gold Standard, the value of each currency was set equal to a set amount of gold, and through a chain rule calculation, the par values for each currency could be determined. Britain was the first country to go onto the Gold Standard, and other countries slowly followed. Under the Gold Standard, using the British Pound as the basis for the system, 1 British Pound = 25.22152 French Francs = 25.22152 Belgian Francs = 20.429 German Marks = 4.8665 US Dollars =12.071 Dutch Guilders = 24.02 Austrian Krone = 18.15982 Danish, Swedish and Norwegian Krone.

Most European colonies used the currency of their mother country, and the exchange rates between the colonies and mother countries differed only by the interest opportunity cost of transferring money from the mother country to the colony or vice versa.